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Monday, June 22, 2009

Should we tax the tall more than the small?

Greg Mankiw and Matthew Weinzierl -- both at Harvard -- co-wrote an interesting article on the theory of optimal taxation entitled Do you really want to tax ability? In this article, the authors argue that according to standard theory, it is optimal to tax tall people more than short people. As a budding economist, I found it to be a fascinating read. For those of you who are budding non-economists, here's a layman's breakdown:

Why tax tall people more? Mankiw and Weinzierl describe well-established economic theory on optimal taxation that dates back to Edgeworth (1897) and owes much to Vickrey (1945) and Mirrlees (1971). What's optimal? If we can observe innate productivity, tax it so that everyone ends up with the same wealth after the tax. In the real world, we never observe actual productivity, but some mix of effort and productivity. And, that complicates the picture.

In a nutshell, the optimal taxation literature tells us to tax whatever individuals cannot influence. That way, the tax does not distort individual incentives. Couched in this framework, Mankiw and Weinzierl (2009) suggest that we tax height. Here's why: It's really hard for someone to change his height, and wealthy people tend to be tall. Therefore, if we want to efficiently transfer resources to the unlucky ones (as Edgeworth suggested we do), we should tax tall people more than short people. It won't affect marginal incentives to work, but it will flow money from rich to poor.

The authors break the population into three groups: tall (6 ft 1 or taller), medium (5 ft 10 inches to 6 ft) and short (5 ft 9 inches or shorter). I'm not going to measure the shortcomings of these height cutoffs, but they do seem to be arbitrary choices. Mankiw and Weinzierl compute that an optimal redistribution program would tax tall people at 7.1 percent, medium people at 3.8 percent and that would provide enough money to give short people a 13 percent subsidy.

Caveats. The authors give three caveats to why we might not want to implement the so called optimal tax. These are:

The tax is discriminatory or may lead to other discriminatory tax schemes. In their words, "some might fear that a height tax would potentially become a 'gateway' tax, making taxes based on demographic characteristics more natural."

The tax is not fair after the fact: "it may be hard to explain why a tall person has to pay more than a short person"

Taxing to redistribute money impinges on liberty. Mankiw and Weinzierl quote Milton Friedman on this point: "I find it hard, as a liberal, to see any justification for graduated taxation solely to redistribute income. This seems a clear case of using coercion to take from some in order to give to others..."

All three of these objections rely on changing the terms of the debate. All of these objections are of the form, "Yes. If you value efficiency, you're right that taxing tall people is the way to go, but I value xxxx. If you value xxxx, the natural conclusion is to not tax tall people more than short people." These are useful critiques, but I think a more incisive critique can be applied -- one that takes seriously the time cost of administering a height tax relative to other tax schemes.

Why might time cost matter? Just like Mankiw and Weinzierl do in their analysis, I still take efficiency as my objective. Whenever we propose a tax policy, it is worth thinking how one could implement the tax. In particular, here is a set of questions a government should ask before implementing a new tax scheme:

Do we have all of the required information? If not, how would we go about obtaining the required information? How can we prevent evasion of taxes? Compared with the alternative, how much time will all of this take? How should we value such time?

As Freidrich Hayek taught us, information and "knowledge of particular circumstances of time and place" make the economy go around. Government policies that are made without regard for the flow of information are very costly. Hayek made this comment with special regard to communism's command-and-control directives versus the free market's price system, but we can apply Hayek's information-conservation principle to compare alternative tax schemes.

Let's use Hayek's information-conservation principle to compare a height tax with our current graduated income tax scheme. I pose this discussion in terms of advantages and disadvantages for a height tax.

Advantage: The right marginal incentives. As the Mankiw and Weinzierl make clear, the height tax has the distinct advantage that it does not change individuals' incentives to work. In this respect, a height tax gets the incentives right. Don't discourage people from working if working is worthwhile.

Disadvantage: The costs of measurement. Compared with a graduated income tax scheme, a height tax has significant informational demands. In particular, I doubt there exists a trustworthy database on people's current height, whereas most American payroll departments keep comprehensive records of income payments to their employees. It could be quite costly to build a height database reliable enough to use as a basis for taxes. That's because implementation of a height tax comes with many questions.

For example, would we measure people's heights at a particular age (say 18)? What about late bloomers? What about taxing people younger than the measurement age? Would we measure people's heights every year? If so, who would administer this measurement? Who would monitor slouching? Who would audit the measurements? Who would develop the standards for measuring people? Shoes on or shoes off? Do people take time off from work to get measured? And so on...

A height tax would not just tax our bank accounts, but also our time -- at least the time it takes to get measured. Given that the government cannot spend that time, this lost time is an additional loss to society.

The take home message. You may just say that these are just messy details of taxing a population, but real life is full of messy details that contort what is actually optimal. These information costs affect what's the best way to tax. Given the informational requirements and the costs of administering a height tax, it might just be optimal to stick to a graduated income tax system. We would have to work out the math, but qualitatively, it could go either way.

Furthermore, the government does not exist just to redistribute money among the population; it has very real demands for tax revenue. Moreover, a height tax would not be enough to cover these expenses. As a result, by imposing a height tax, we would not actually save any of the administration cost of the old tax scheme. It would be added cost to get added tax revenue.

That sounds like a bad deal to me, but then again, I am 6 ft 1 -- this tax scheme is out to get me. I hope we never see the day when Uncle Sam, pencil in hand, tells me to stand tall. Although it is nice to think about, when applied to the reality of raising taxes, a height tax just doesn't measure up.

1 comment:

haha! I'm glad economists think about these sorts of things. I do, too... well maybe not in so much detail, though. When we moved to Germany, I came up with a theory that everyone should be allowed to bring X pounds onto the plane, not 100 pounds of luggage plus you and whatever you're wearing. My theory, of course, is totally selfish because I want to be able to bring more on the plane to my new home.You HAVE to do more posts like this one, Tony. It's so eccentric that it's fun.Katie